March 28, 2023
A tax credit is a dollar-for-dollar reduction of your tax liability. After you’ve calculated your federal taxable income and computed the tax on it, you can subtract any income tax credits that may apply to arrive at the amount of tax you must pay or the refund you’ll receive.
A tax deduction reduces the income on which your taxes are calculated, and so only reduces your tax liability on a percentage basis (as determined by your marginal income tax rate). By contrast, a tax credit reduces your actual tax liability on a dollar-for-dollar basis.
For instance, if you’re in the 24 percent marginal income tax bracket, a deduction of $100 will save you $24. But a tax credit of $100 will save you $100 regardless of your tax bracket.
The child tax credit provides a tax credit of $2,000 per qualifying child. For 2021 only, the credit was increased to $3,000 per qualifying child ($3,600 for qualifying children under age 6). The credit is phased out for taxpayers with modified adjusted gross income (AGI) above certain levels. A portion of this credit may be refundable for certain taxpayers on IRS Form 8812, and special rules may apply for taxpayers with three or more qualifying children. For most individuals, the credit was fully refundable for 2021. For 2018 to 2025, a $500 nonrefundable credit is available for a qualifying dependent who is not a qualifying child.
You may be able to take this credit if, in order to work, you pay someone to care for your child who is under age 13, your qualified disabled dependent, or your disabled spouse. Several requirements and restrictions apply. You use Form 2441 to calculate the amount of this credit.
Caution: You generally can’t claim this credit unless you report the correct name, address, and taxpayer identification number of the dependent care provider. The taxpayer identification number requirement is waived in the cases of certain tax-exempt providers.
To claim this credit, you or your spouse must be either of the following by the end of the year:
In addition, your AGI as well as your total nontaxable Social Security and other nontaxable pension income must fall below certain limits.
The amount of credit for a qualified fuel cell motor vehicle is based on the weight of the vehicle and when the vehicle is placed in service (vehicles must be placed in service after December 31, 2005, and purchased on or before December 31, 2021). A list of qualifying vehicles and corresponding credit amounts can be found on the Internal Revenue Service website.
To qualify for this credit a motor vehicle must meet certain emission standards and draw propulsion from a battery that has a capacity of at least five kilowatt-hours and is capable of being recharged from an external source of electricity. The maximum credit is limited to $7,500. The credit phases out for a manufacturer’s vehicles once 200,000 vehicles have been sold.
The American Opportunity (Hope) tax credit is for taxpayers who pay certain higher education costs. It’s available for qualified higher education expenses that you (or your spouse or dependent) incur at an eligible educational institution. The maximum tax credit is generally $2,500 per student per year for qualified tuition and related expenses incurred during the first four years of post-secondary education. The amount of your credit (if any) depends on the level of your AGI. To qualify for this credit, you must meet several requirements. Up to 40 percent of the American Opportunity tax credit is refundable. We’ll dig deeper into Education Credits in my next blog: Education Tax Credits and Deductions.
The Lifetime Learning credit is generally worth up to $2,000 per year for qualified tuition and related expenses incurred for course work at eligible educational institutions. The credit is not limited to the first four years of post-secondary education (the credit is also available for graduate and professional-level courses), and you may enroll as less than a half-time student and still qualify. We’ll dig deeper into Education Credits in my next blog.
The tax credit for IRAs and retirement plans was designed to encourage certain low- and middle-income taxpayers to save for retirement. Qualifying taxpayers may claim a nonrefundable income tax credit for contributing to certain tax-deferred retirement savings vehicles, such as IRAs, 401(k) plans, and others. If you’re eligible, the amount of your credit (if any) will depend on your AGI, your filing status, and the amount of your IRA and retirement plan contributions for the year.
If you pay income taxes to both the United States and a foreign government on the same income, you may choose on your U.S. federal income tax return between claiming a deduction or a tax credit for the foreign income taxes you paid. In most cases, it is more advantageous to take the credit. The credit applies to income taxes you pay to a U.S. possession, a foreign country, or to any province, state, city, or other subunit of a foreign country.
Health-care reform legislation passed in 2010 requires most Americans to have qualifying health insurance. As part of this change, the legislation creates a refundable premium assistance credit beginning in 2014 to help lower-income individuals purchase coverage. To be eligible, a person’s household income must meet certain limits. The credit is calculated on a sliding scale, based on income.